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The Dark Pools’ Choice: Go Into the Light or Down the Drain

In a letter to the operators of 15 dark pools, Finra asked for more detail about who knows what happens in these unlit exchanges.

It’s not the End of Dark Pools but we might be entering the last of the Good Ol’ Days.

The unlit trading venues where buyers and sellers meet in the dark and trade large blocks of stocks without knowing the identity of the counterparty are facing greater scrutiny. For a trading method that has been around for decades, the scrutiny from regulators has grown from benevolent neglect to outright laser-like focus. The Dark Pools are about to get brighter.

Last month, financial industry self-regulator Finra sent out a letter of examination to the operators of 15 US dark pools. The Financial Industry Regulatory Authority wanted to clarify what the operators of these lightly regulated dark pools do and how they do it. Mainly, Finra asked the dark pools to explain if other entities inside the firms that run the dark pool have access to information of the dealings inside the dark pool.

In short, does a dark pool operator’s prop trading desk get a heads-up when a big deal is about to go down?

Here’s a sample of what Finra asked the operators of these dark pools:

If the Firm has an affiliate, does the Firm allow its affiliate's proprietary traders, including market makers, to enter orders/quotes, or other trading interest into the ATS? If so, state how this occurs and how this is disclosed to Subscribers. Please provide copies of any written disclosure or other evidence of disclosure.


If the Firm has any affiliates, state whether the Firm will attempt to cross a Subscriber's order with the interest of any such affiliate prior to entering the order into the ATS. If so, describe how this process occurs and how this is disclosed to Subscribers. Please provide copies of any written disclosure or other evidence of disclosure.

Judging by these questions the regulators clearly don't know what is going on inside the dark pools. As John Malitzis, executive vice president of market regulation at Finra, tells the Wall Street Journal.

"We want to understand whether dark pools are disclosing to their customers how their orders work and whether customers are informed who their orders will interact with," he says.

"A big part of this is to get an understanding of practices that may or may not be problematic," he adds.

Finra is not alone in turning up the heat on dark pools. Since the Flash Crash of 2010, the SEC has ramped up its monitoring of this lightly regulated corner of the marketplace. Smelling blood in the water and sick of seeing their trading volume nibbled away, the heads of the major US stock exchanges are pushing for a new "at trade rule" that would divert more trades from dark pools back to the traditional exchanges where these trades once took place. And this isn’t just happening in the US - regulators from other nations want to look deeper into these unlit exchanges.

For a method of trading stocks that started in 1986 - yes, four US presidents ago - these questions and regulatory oversight are long overdue. Let’s see how the dark pools respond. Phil Albinus is the former editor-in-chief of Advanced Trading. He has nearly two decades of journalism experience and has been covering financial technology and regulation for nine years. Before joining Advanced Trading, he served as editor of Waters, a monthly trade journal ... View Full Bio

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